Don’t believe the headlines – the world’s biggest economy is booming

Financial and media commentators spent much of the second half of 2006 predicting a US housing market crash and an economic slump. True, the housing market did weaken last year, but US GDP figures out yesterday paint a completely different picture.

US GDP in the fourth quarter last year was 3.5% (annualised), the strongest Q4 number since the sizzling 7.3% recorded in Q4 1999. Looking at US GDP on a year-on-year basis shows a similar story – US growth in 2006 was 3.4%, stronger than 2005, level with 2004, and only marginally behind the 3.7% record in 2003. Not since 1999 has the US economy grown significantly faster, when it expanded by 4.7%.

How did bond markets react to the news? Well, not as dramatically as you might think, largely because US investors have already significantly altered their interest rate expectations over the past two months. At the beginning of December, the US bond market was fully pricing in 3 US rate cuts, with about a 50% chance of a fourth. Today, the US bond market is only pricing in an 80-90% chance of a US rate cut this year.

But is a rate cut consistent with a booming US economy and US CPI inflation at 2.5%? I don’t think so. I expect US rates to remain on hold over the medium term – in fact, depending on how things pan out, there may even be another rise on the cards.